Variable annuities allow investors to engage in tax-deferred investing such as for retirement in amounts greater than permitted by individual retirement or 401(k) plans. In addition, many variable annuity contracts offer a guaranteed minimum rate of return (either for a future withdrawal and/or in the case of the owner's death), even if underlying separate account investments perform poorly. This can be attractive to people uncomfortable investing in the equity markets that do not guarantee a rate of return.
With a guaranteed rate of return, variable annuities as well as fixed annuities are generally limited in their potential for growth. To maximize growth, some annuities invest funds directly in the stock market through the purchase of mutual funds. The inherent risk with this type of direct investment in the market threatens the stability of fixed and variable annuities without necessarily leading to additional gains. An alternative is an equity indexed annuity which invests in a derivative instrument, the equity index. Typical equity indexed annuities still offer a minimum rate of return while allowing the annuitant to participate in the market by crediting the annuity based on a formula that is linked to the performance of the equity index. Unfortunately, the interest rate realized by the current set of equity indexed annuities does not match the performance of the equity index the annuity invests in. Instead, the rate of return is only a percentage of the performance and will depend on a number of variables including, inter alia, the participation rate, choice of index, administrative costs and management fees.
As such, there is a need to provide investors with a financial vehicle for a tax-deferred growth strategy which includes a built-in protection feature providing investors the opportunity to invest for growth with some downside protection. There is also a need for a product which offers participation in the performance of the equity or commodity index with a performance cap and a downside buffer.